#16: Rethinking India’s Growth Path?
Review of Raghuram Rajan and Rohit Lamba's recent book, and other things.
In the interim budget for this financial year, the union government increased the allocation to its flagship production-linked incentive (PLI) scheme by 33% to ₹6,200 crore for FY 2024-25. Launched in 2021 with a total outlay of ₹1.98 lakh crore, the scheme aims to incentivise firms to manufacture in India.
While many critics of this government may disagree with specific decisions under PLI, most of them largely agree that labour-intensive manufacturing is how India gets rich. For me, the most interesting part about Raghuram Rajan and Rohit Lamba’s recent Breaking the Mould was that it challenges this idea.
How did other countries develop? From centuries to decades
Rajan and Lamba explain the classic development narrative revolves around the transition from farms to factories. In some parts of the world, people slowly migrated from rural small-scale farming to urban factories. With technological improvements and economies of scale, these factories started producing more stuff with the same resources. Economists refer to the amount of goods produced by each worker as productivity.
With higher productivity, the workers earned more. And they could spend more on things they wanted with more money. This created a virtuous cycle, meaning demand for more workers led to higher wages and urban migration.
More money also meant demand for services, so many working people moved to services. Think of a restaurant or salon staff. Early developed countries such as Britain and parts of Europe experienced this transformation over centuries. However, the ‘Asian tigers’ — Hong Kong, Singapore, South Korea and Taiwan — achieved high-income status in mere decades.
How did the Asian tigers achieve rapid growth? Two factors stand out to the authors. First, they engaged in catch-up growth, using existing knowledge from developed nations without much first-hand innovation. Second, they could sell their produce to rich countries, which created a virtual cycle. As people got rich from exports, they spent more, creating more and higher-paying jobs locally.
In India, we lament missing this path to fast development, losing to China in global exports in the 1980s. The authors explain that we lagged in several areas. We had poor basic education. We did not empower the local governments to compete and innovate. Our flawed policies of licence raj made it difficult for honest businesses to grow and participate in the global markets.
Many still advocate retracing what worked for the Asian tigers in the 80s, but the authors advise some caution. They argue China still has cheap labour and other countries, such as Malaysia, Thailand and Vietnam, offer competitive labour with better training, experience, logistics, and connectivity within the Asian market. Therefore, India’s presumed advantage in manufacturing is not as clear-cut as commonly believed.
India’s unique development path: service exports
Rajan and Lamba argue that India should carve out its unique development path by playing to its strength: exporting services. This allows us to benefit from higher value-added segments instead of low-skill manufacturing. They argue that the typical limitations of exporting services are fading. Technology and remote work have opened new possibilities. We can offer high-value services such as education, consulting, and telemedicine to the world at competitive prices from India.
The book covers case studies of Indian entrepreneurs providing services to the global market and creating manufacturing jobs for services. Hence, the authors say if we can also compete in manufacturing, that is certainly a bonus, but our policies should not try to direct outcomes toward manufacturing.
Despite the unconventional development path the authors suggest, their policy suggestions are relatively conventional. This is good because their advice builds on years of research, and those who disagree with their argument can also consider it. They caution against hubris of hyper-targeted benefits and reiterate that policies should only create enabling frameworks and not direct outcomes. The exact course is for entrepreneurs to decide. Their anecdotes — particularly Rajan’s stint as the RBI governor — add much richness to their arguments.
The authors argue for governance reforms in India and offer some specific suggestions to enhance transparency, decentralisation, and accountability. They reiterate the need to focus on human capability by investing in and improving health, nutrition, and education. Additionally, they suggest a National Research Fund (NRF) to put India at the cutting edge of research and development in select areas. Rajan and Lamba concede that many of these ideas are old and have had little success in implementation but stress the need for persistence.
My thoughts
I believe that Rajan and Lamba do not see the book as definitive and have aimed to spark a debate among policy thinkers. The book’s accessible and jargon-free writing suits a wide audience: anyone interested in the Indian growth story.
The book offers convincing logic to argue service exports can now produce a lot of employment but does not go far enough to show that it can be enough, which is the main scepticism around services in India. While the book uses case studies and examples, the service argument needs more grounding in data.
Rahul Jacob has sympathised with the book’s pushback against PLIs but has strongly opposed giving up on low-skill manufacturing:
But can we therefore turn away from low-end manufacturing? This doesn’t make sense, given that, as the authors themselves point out, India’s labour participation rate has now fallen to just 46 out of every 100 in the working age cohort, significantly below levels in Brazil and Indonesia. Services exports from global capacity centres in India are growing apace. Yet, the multiplier effects from that in terms of low-end service jobs, such as being a cook, street cleaner or security guard, for Prof. Erali and others as the book approvingly outlines, are nowhere near sufficient. Before we dismiss certain manufacturing jobs as low-end, perhaps we could ask workers in garment factories whether they would prefer to be Prof. Erali’s cook. And, rather than be further distracted, New Delhi needs to urgently conclude broader FTAs so our factories’ products are not hamstrung by import duties for years to come when bidding for business against Vietnam and Bangladesh, whose garment exports are now more than double ours.
There is an increasing appeal of service-led development. Economist Dany Rodrick, an early proponent of manufacturing export-led development, is now arguing that there is not much to gain from it anymore. In his recent paper with the Nobel Laureate Joseph Stiglitz, they argue that developing countries should prioritise green energy and non-traded services over manufacturing and exports.
Noah Smith has summarised these arguments and pushed back, arguing that their idea of non-tradable services is largely speculative, taking the example of Bangladesh, which continues to grow through manufacturing.
In my opinion, to tell these countries to give up on industrialization right now, at the cusp of their big moment, and to refocus on nontradable services instead, would be to do them a deep disservice. Instead, I think they should keep trying the traditional model of development, taking advantage of trends like friend-shoring and de-risking to encourage FDI and build up their manufacturing sectors. If that model eventually breaks, then it breaks, and we find something else. But from where I’m sitting, it doesn’t look broken yet.
A new debate has started. As always, there won’t be clear intellectual ‘winners’. But what becomes fashionable has huge implications for global development. We must watch this space closely.
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